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Lowe’s has agreed to buy Orchard Supply Hardware for approximately $205 million on the same day Orchard Supply filed a petition for Chapter 11 bankruptcy.

The purchase agreement would enable Lowe’s to expand through a new store format and reach a new customer base in California with the addition of Orchard Supply’s smaller-format metro store locations. Lowe’s plans to have Orchard Supply operate as a separate, standalone business, retaining its brand under the leadership of Orchard Supply’s current management team.

Based in San Jose, Calif., and with fiscal 2012 annual revenue of $657 million, Orchard Supply operates 91 neighborhood hardware and garden stores, primarily located in densely populated markets in California. Under the terms of the transaction, Lowe’s would acquire at least 60 of these stores based upon further due diligence on the locations.

On average, the Orchard Supply stores, which offer a product selection focused on paint, repair and backyard categories, include approximately 36,000 square feet of selling space, compared to 113,000 square feet of selling space for an average Lowe’s home improvement store. Lowe’s currently operates 110 stores in California.

“Orchard’s neighborhood stores are a natural complement to Lowe’s strengths in big-box retail, offering smaller-format hardware and garden stores catering to the needs of local customers,” said Robert A. Niblock, Lowe’s chairman, president and CEO. “Strategically, the acquisition will provide us with immediate access to Orchard’s high-density, prime locations in attractive markets in California, where Lowe’s is currently underpenetrated, and will enable us to participate more fully in California’s economic recovery.”

Because of Orchard Supply’s petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Delaware, the transaction is subject to an auction and Bankruptcy Court approval. Orchard Supply’s agreement with Lowe’s will serve as the “stalking-horse bid” in the auction process, allowing Orchard Supply to avoid low bids on its assets from any other potential buyers submitting competing bids.

Under the terms of the agreement, Lowe’s would receive a termination fee of 3 percent of the purchase price should it not be successful in acquiring Orchard Supply’s assets in approximately 90 days. In addition, subject to court approval, for an alternative bidder to be successful, it must outbid Lowe’s by a minimum of $12 million, representing $5 million in addition to the termination fee and an expense reimbursement of $850,000.